Dollar holds firmer across the board as markets digest US-Iran conflict

Since last year, the dollar hasn’t been the favoured haven currency in most negative risk events. In fact, it’s also not the yen but instead the franc took over the mantle. That amid the own problems brought about by the US administration and Tokyo’s policy directive change after Takaichi took over as prime minister.But in the latest conflict between the US and Iran, the dollar is coming out well on top as the preferred destination for flows. So, what is it about this situation that is different? And where do we go from here? Let’s break it down.The simple supportive case is the petrodollar one. Despite diversification over the years, the fact remains that the vast majority of global oil is still priced and settled via the dollar. If oil prices surge from $70 to $100, massive oil importers such as Japan and India will have to pay over 40% more dollars just to secure the same amount of oil barrels and energy imports.And the thing with the latest geopolitical escalation in the Middle East is that this conflict could drag on for much longer. The baseline scenario is that it could last for a few weeks. However, the situation is fluid and for oil prices it all hinges on passage through the Strait of Hormuz.As such, major oil importers have to be prepared for that possibility. So, to see the dollar facing strong bids may not be too surprising. That especially as a reminder that this was a market that was short dollars by quite some margin in the run up to the US-Iran conflict.Besides that, higher oil prices also have spillover effects to US policy too. It feeds to stronger inflation pressures, even if temporary, but that could be enough to put the Fed off from cutting rates further until the dust settles. For now, Fed market pricing hasn’t changed all too much but is worth keeping an eye out for if the situation in the Middle East is prolonged.Traders are still pricing in ~57 bps of rate cuts by year-end with the next full 25 bps rate cut priced for September now. The odds of a rate cut in July has slipped to around a 91% probability right now.All of that aside, it could be a simple case of markets just reverting to old habits in seeking shelter in the place that they know best over the years. The dollar has always been the safe haven destination for any major global conflict, especially when it comes to military and geopolitical feud – let alone both.And especially now, there’s just so, so much uncertainty up in the air over how things are going to play out. What’s the next step from Washington? Are global powers underestimating Iran? What about Gulf nations, are they just going to sit back or retaliate as well?There’s definitely a lot to consider with equities also being sold off heavily, keeping risk trades in a more nervous spot ahead of the Wall Street open later. Here’s a snapshot of dollar pairs at the moment:The yen isn’t doing so well as Japan will be hurt most by surging oil prices. As for the franc, risks of SNB intervention is helping to limit further gains so far on the session at least.
This article was written by Justin Low at investinglive.com.

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